IMF currency warning comes true for emerging markets

The IMF said advanced economies should exercise caution in lifting interest rates because emerging markets were a source of concern.
AFR

by
Vesna Poljak

Emerging markets’ currencies have started the year on a weak note, validating the International Monetary Fund’s warning this week of a risk of capital outflows from vulnerable economies.

As the developed world led by the United States unwinds ultra-easy policy settings and anticipates stronger growth, foreign capital is returning to the old guard where yields are rising with the economic recovery.

That poses a problem for emerging markets and especially those ­economies with large current account deficits.

“One of the key takeaways from 2013 was the very harsh impact on emerging markets currencies of the first bout of taper talk," said Westpac senior currency strategist Sean Callow, referring to the Federal Reserve’s signalling of a reduction in stimulus mid-2013.

The Fed will slow the pace of bond purchases as of this month in a development economists call “tapering" but how quickly it will exit quantitative easing altogether is unclear.

“When
[Ben] Bernanke
kicked things off in the second quarter last year with his talk of reducing stimulus, that sparked a wave of outflows," Mr Callow said. “Because of that episode there is a great unease about the potential ongoing impact as the Fed taper continues."

Soft performers

Argentina’s peso has been the weakest performer, after Argentina intervened in foreign exchange markets to devalue the peso in the face of dwindling foreign currency reserves. Experts say Argentina is facing its own unique set of challenges.

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But the Turkish lira, South African rand, Russian ruble and Colombia’s peso are all softer over the past month.

“The general sense is money is flowing into developed markets," Mr Callow said. “It’s more a case of emerging markets jitters rather than active attempts to undermine them [as is the case for Argentina]."

“Portfolio shifts and some capital outflows are likely with Fed tapering," the IMF said. “When combined with domestic weaknesses, the result could be sharper capital outflows and exchange rate adjustments."

However,
National Australia Bank
global co-head of foreign exchange strategy, Ray Attrill, said any future capital outflows were unlikely to match the severity of those witnessed last year.

“Yes, it is a risk, but my sense is it’s maybe a little bit overplayed," he said.

Markets were not particularly well prepared for the so-called taper tantrum of mid-2013, he added, and “we’re not seeing the same kind of stress now that we were then. We have seen some capital flight but it’s not of the scale of the middle of last year."

Mr Attrill pointed to trends in US ­10-year Treasury yields which the Fed has managed to keep a lid on, unlike the first sign of tapering when yields spiked quickly.

The 10-year was yielding 2.85 per cent on Thursday but rose to 3 per cent in September from less than 2 per cent in May as expectations of an imminent reduction in stimulus mounted. Yields revisited 3 per cent again at the end of December.

“There are risks. A lot of the outflows that we saw back in the middle of last year came when US bond yields were rising sharply," Mr Attrill said. “Now I think because the Fed has done a ­reasonably successful job in distinguishing between tapering and tightening, effectively US bond yields haven’t really punched through the highs."

He also observed that emerging markets had a lot of unique problems that would influence investors. But equally, emerging markets’ growth was still expected to outpace developed market growth this year and that would be enough to pacify some investors in spite of unique geopolitical risks.